CMG: THOUGHTS INTO THE PRINT

CMG reports on Monday, July 21st AMC.

Takeaway: CMG has been the best performer in the restaurant space over the past year (+57.1%) and is a name we continue to prefer on the long side. We are cautious, however, about the upcoming quarter given notable inflation in avocado, beef and cheese prices. Recall that Chipotle only began taking ~6% of menu price in early June (~1,000 units), with the system-wide rollout likely completed by the end of 2Q. Therefore, we question the extent to which management was able to protect margins in the quarter in the face of pressing inflationary pressures. Looking out into 2H14, same-store sales momentum and the full impact of pricing suggests estimates are too low. We'd therefore be buying on any post-earnings weakness.

Investment Thesis Overview

Chipotle continues to be one of our favorite longs in the big cap QSR space, highlighted by a best in class operating model and recent same-store sales momentum. Traffic grew 13.4% in 1Q and management has several drivers in place (faster throughput, non-traditional marketing, GMO-removal, sofritas, catering) to help capitalize on this and enable them to deliver +15% revenue growth and +20% EPS growth for the next few years.

Food inflation driven by high beef, avocado and cheese prices continues to be a cause for concern, but a MSD price increase should mitigate these pressures in 2H14 and 1H15. We believe Chipotle has ample pricing power which should allow them to raise prices with little resistance and give another leg up to margins.

Chipotle also continues to attract investors with two potential growth drivers (ShopHouse, Pizzeria Locale) and a strong balance sheet (room to accelerate buybacks).

Earnings Expectations

For 2Q14, the street expects revenues of $989.1 million (+21% YoY), adjusted EPS of $3.09 (+9% YoY), and company owned same-store sales of +10.2% (incl. +2% price). We’re cautious on earnings given food inflation and little impact on the Q from June price increases.

Same-Store Sales Trends

Given recent momentum and menu pricing of ~6%, we expect two-year same-store sales to accelerate throughout 2H14 and into 1H15.

Margins

The 2Q margin outlook is dicey given food cost pressures. As such, we expect to see notable restaurant level and operating margin contraction. However, this trend should turn moving forward, as we expect price increases in 2H14 and 1H15 to drive restaurant level and operating margin expansion for the next several quarters.

Valuation

CMG is currently trading at 43.34x P/E and 21.92x EV/EBITDA on a NTM basis.

Risks

This quarter depends on the company’s ability to maintain prior same-store sales momentum and mitigate food cost pressure by leveraging labor and other operating expenses. 2H14 performance will also depend on these factors, but will have the full benefit of ample price increases, which should give restaurant and operating margins another leg up. Any pushback to these price increases (though unlikely), would be a significant blow to our bullish thesis. Highly promotional QSRs are trying their best to make this happen. A decline in new unit productivity would also raise a red flag, as CMG begins moving into smaller markets.

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